Krugman’s double standard

Paul Krugman has gotten a lot of flack from people who noticed that he seems to have a double standard.  He argues that the US should threaten China with trade sanctions, in order to force them to revalue the yuan.  In earlier posts he acknowledged that a strong yuan would not be a problem under normal circumstances, as the US could simply offset the negative impact on AD with an easier money policy.  (Note to commenters; this argument is unrelated to the fact that the yuan is pegged to the dollar.)

Krugman also argues that the US and Europe are stuck in liquidity traps, and hence monetary policy cannot be used to offset the effects of the undervalued yuan.  But when Europeans complained that monetary stimulus in the US was weakening the dollar and hurting their export industries, he made this sarcastic comment:

In other words, how dare you act to protect your economy from deflation and double-digit unemployment? By doing so, you make our inappropriate tight-money policy even more destructive!

I thought his retort was great, and said so.  But I think you can see the problem.  Suddenly the concerns of the country with the strong currency are brushed aside; they should just adopt their own monetary stimulus.  What happened to the idea that monetary stimulus doesn’t have any effect at the zero bound?  And if the Europeans can do that in response to the weak dollar, why can’t we do that in response to the weak yuan?

In a new post Krugman acknowledges the critics, but fails to dig himself out of the hole he’s in.  To his credit, he doesn’t mention the yuan peg, which is a phony issue raised by some of my commenters.  That’s not the problem in Krugman’s view– the problem is that the Fed can’t raise AD because we are at the zero bound.  So how does he defend himself?  He changes the subject, arguing that we have much more reason to complain about the weak yuan than the Europeans have to complain about the weak dollar:

In various comments and other places I keep seeing people compare European complaints about the weak dollar to American complaints about the undervalued renminbi. It’s a false equivalence, which should be obvious if you think about the basics of the situation.

What the United States is doing is an expansionary monetary policy in the face of a depressed economy and threats of deflation; what else do you expect us to do? Now, one effect of that policy, if it isn’t matched abroad, is a weaker dollar “” but that’s not the goal of the policy.

But even if he is right (and I’ve argued he’s wrong for all sorts of reasons), this argument does not rebut the charge that he changes the argument when the US is the country in the hot seat.  We critics do understand that one might be able to make a stronger argument for a weak dollar than for a weak yuan.  What we complain about is that he assumes the ECB can do nothing to boost AD when the issue is China, but when there are complaints against the US depreciating the dollar the liquidity trap seems to vanish into thin air.  That’s the double standard.  Krugman’s smart enough to know he has a weakness there, and so he also makes this argument:

What about the argument that America can offset any effects from China’s policies through looser money? Well, I don’t really get why some commentators can’t grasp the distinction between the proposition “quantitative easing is worth trying, and would probably help” and the proposition “quantitative easing will allow the Fed to do whatever is needed, never mind the zero lower bound.” I subscribe to the first, not the second.

This is a game he’s been playing from the beginning.  When it suits his purpose to claim monetary policy can do nothing (i.e. calling for fiscal stimulus or bashing the Chinese) he does so.  When it suits his purpose to claim that monetary policy still has unused ammunition (as when he’s bashing the Fed, or bashing the ECB) suddenly monetary policy can do much more.  His only way out is to confuse the issue—maybe it’s a 50/50 proposition.  Maybe monetary stimulus will work, maybe it won’t.  But notice how when he attacks China it’s all about the 50% chance it won’t work, and when he attacks the ECB it’s all about the 50% chance it will work.

Of course the truth is it will work.  Indeed the entire discussion of how the Fed is depreciating the dollar makes no sense if we were really in a liquidity trap.  That’s because when you are in a liquidity trap monetary stimulus has no effect on the exchange rate.  So let’s get serious here–we all know that the Fed can offset China’s impact on NGDP if they want to.  Indeed they can raise NGDP at Zimbabwean rates if they really set their minds to it.  Krugman’s right that they are too conservative to do that–but that just means we have  no one but ourselves to blame for our unemployment.  The Chinese have every right to scold our Fed just as Krugman scolded the ECB.  (Ironically, the Chinese are doing the opposite!)

Earlier Krugman and I had a debate about whether the Bank of Japan had tried and failed to inflate, or had never really tried at all.  He takes the former view, which required him to make the deeply implausible argument that even a fiat money central bank might get stuck in a liquidity trap.  I pointed out that the BOJ had repeatedly tightened policy at any sign of even a tiny increase in the price level, hence it was no surprise that Japan fell back into deflation any time the inflation rate poked its head above zero.

I recall that Ryan Avent thought Krugman’s reply actually supported my argument.  Now Matt Yglesias has weighed in the the issue.  As you know, Yglesias’s Keynesian views on fiscal stimulus are much closer to Krugman’s than to mine.  But he is also a very smart and fair-minded progressive.  Here’s how he sees the evidence:

I heard from some readers, for example, that the Bank of Japan spent a lot of time trying to create inflation and failed. That’s not really what happened. Instead, the Bank of Japan spent a fair amount of time trying to fight deflationand had limited but real success. They always indicated, however, that they wanted “price stability” not inflation and certainly not catchup level targeting of anything. This kind of stop/start policymaking does exactly what it’s supposed to do””it prevents collapse without being unduly unorthodox””but it can’t really lift the price level or the economy. But that’s not to say policymakers don’t have the ability to say that unorthodox measures will remain in place until full employment resumes. Thus far, in both Japan and the US, they’ve simply chosen not to do so.

I can’t imagine how any fair-minded observer could look at all the evidence on the BOJ and reach any other conclusion.  This blows away Krugman’s argument about the US being victimized by China.  How can we claim to be a victim when we haven’t even tried to stimulate?  Especially as monetary policy can do the job almost costlessly.  And how do I know we haven’t made a good faith effort?  Because Krugman said so today!

There are multiple things wrong with that paragraph “” but what on earth would give one reason to consider our political system “responsive”? The truth is that we’re responding worse than Japan did.

Krugman’s right.  Our attempts to boost AD have been completely pathetic.  So why the heck are we blaming the Chinese for our failures?

Krugman’s right about one thing, we are in a recession and China isn’t.  So we need the stimulus more than they do.  But the issue is not how much unemployment China has now, but rather how many Chinese would lose their job if China sharply revalued the yuan. I favor a gradual appreciation in the yuan, and the Chinese government has recently resumed the policy of gradual appreciation that was conducted from 2005-08.  But here’s what China expert Michael Pettis says might have if there was a sharp appreciation in the yuan:

And so there is a good chance that the US will overreact, and will use the threat of tariffs to force the renminbi to appreciate much faster than China can absorb.

.   .   .

So after years of dragging its feet, postponing a rebalancing, and forcing rising trade surpluses onto the rest of the world, China may have to adjust its currency policies so quickly that it risks a sharp contraction at home.

Note that unlike me, Pettis agrees with Krugman’s argument that the weak yuan has hurt the US.  But he is still very concerned about the impact of a sharp revaluation.  Think about it.  How could such a policy help the US by sharply curbing our imports from China, without costing the jobs of many Chinese workers in the export sector?  China’s a very big country, I could easily foresee more jobs being lost in China’s export sector, than gained in the US (even if you accept the zero sum approach used by some protectionists.)

So even if you accept Krugman’s argument that yuan appreciation would help the US (and I don’t) he’s still asking a country with 1.3 billion mostly poor people to take a chance on a policy that Michael Pettis says could cause severe problems, all because of our failure to boost AD.  And even Krugman blames our own policymakers for that failure.   How can a progressive make that argument?

Yes, I know, I don’t get the fact that we can’t be 100% sure that monetary stimulus will work.  And can he or anyone else be 100% sure a sharp yuan revaluation wouldn’t cost China millions of jobs?  Especially given that China’s economy slowed sharply and experienced deflation after the yuan became overvalued in 1998?

HT: Master of None



28 Responses to “Krugman’s double standard”

  1. Gravatar of marcus nunes marcus nunes
    18. October 2010 at 18:06

    When I read Krugman this morning I thought: “The guy is in a maze, turning left and right just to trick his followers into thinking he´s closer to finding the way out, but in reality losing whatever bearing he had left at each turn”

  2. Gravatar of Ram Ram
    18. October 2010 at 18:11

    One of the things I have noticed about Krugman’s China-bashing is that DeLong, Thoma, etc. have been echoing him less frequently than usual on this topic, even though they have signaled sympathy for his position in the past. I wonder if that speaks to Krugman’s unique position as a writer for the NYTimes as a motivation for his writing on the subject. After all, when the economic growth slows, the public becomes increasingly nationalistic and increasingly blames other countries for its economic woes. This is the best time for a writer like Krugman to be suggesting that China isn’t “playing by the rules,” for it makes it out to be the knowingly guilty party. I hope I’m wrong, but it’s pretty ugly stuff in any case.

  3. Gravatar of OGT OGT
    18. October 2010 at 18:56

    Glad to see you quoting Pettis. But, I don’t see how you can reasonably claim to accept the notion that revaluation could hurt Chinese workers without accepting his contention from the same analysis that it is hurting US workers.

    Pettis also notes that the Chinese government has been dragging its feet on adjustment, due in part to serious pressure from interests invested in the status quo, making the eventual adjustment more likely to be sharp and painful.

    But one way I do agree with Yglesias is that QE2 is likely to hasten the end of Bretton Woods II, and that is probably a good thing and necessary thing. Unfortunately China’s capital controls mean that the weight of adjustment will likely fall disproportionately on other emerging markets, as the Finance Minister of Chile recently pointed out.

    At present the gap between economic growth and interest rates in the US and in emerging markets is growing. Thus the US dollar needs to depreciate against emerging market currencies. That is where the catch lies. Against which should it fall? Clearly, it can only depreciate against those that move according to market forces.

    This means that if the exchange rate between the Chinese and American currencies moves very little, then other emerging markets bear the brunt as the dollar adjusts elsewhere. Countries like Brazil, Chile, Colombia and Peru – as well as developed but fast-growing economies such as Australia and South Korea – face unpleasantly large appreciation pressures. These are placing a heavy burden on their export and import-competing sectors, principally agriculture and manufacturing.

    Some countries find this problem is made worse by a loss of market share to China in third-country markets. China and Mexico, for example, compete as exporters to the US. But since 2009 the Mexican peso has appreciated 9 per cent against the dollar while the renminbi has appreciated 3 per cent. This puts extra pressure on Mexican producers, which will get worse if this trend continues….

    On the Chinese side greater flexibility in exchange rate is needed. Indeed, such a policy should be in the interests of both China and America. By letting market forces have a little more influence, the Chinese would reduce the need for QE in the US, and in turn offset protectionist pressures there. This would allow China to share with its emerging market trading partners a more proportional part of the burden of the global currency adjustment that is now under way.

  4. Gravatar of Doug Bates Doug Bates
    19. October 2010 at 03:31

    I too am surprised by all the newspaper pundits who claim that the Fed is out of ammunition and that not much more can be done. I figure this is because the best ammo — chucking the payment of interest on reserves while dramatically increasing the monetary base — is considered unthinkable and unmentionable, because it could lead to a potentially uncontrollable bout of above-target inflation. Or even, shudder, Zimbabwe 😉

    Because if there is one thing Americans hate even more than recession, it is inflation of more than 2%. So, we’ll just muddle through for a decade or two, because the unemployment we have is less scary than the inflation we don’t.

  5. Gravatar of For win-win solutions – Economics – For win-win solutions - Economics -
    19. October 2010 at 04:01

    […] Krugman and his China animus. So today I'll outsource the job of pushing back against him. Read Scott Sumner and Niklas Blanchard. And read Matt Yglesias:The Chinese government’s discomfort with monetary […]

  6. Gravatar of scott sumner scott sumner
    19. October 2010 at 04:54

    Marcus, I get whiplash reading him.

    Ram, I really think it must be something else. He went strongly against the nationalistic mood right after 9/11. I think he may visualize China in terms of their rich and arrogant leadership, not the 1 billion poor Chinese who might be affected by our policies.

    OGT, You said;

    “Glad to see you quoting Pettis. But, I don’t see how you can reasonably claim to accept the notion that revaluation could hurt Chinese workers without accepting his contention from the same analysis that it is hurting US workers.”

    Very simple. I make the reasonable assumption that China controls the value of it’s currency and we control the value of ours. And note that even Krugman doesn’t agree with you. Your argument implies that the strong yuan would cost us jobs even if we weren’t in a liquidity trap. But Krugman doesn’t believe that.

    I plan a post later today on why Bretton Woods 2 isn’t ending. I also have a new post up at The Economist, so you can look at my ideas on BWII now if you are interested.

    BTW, I’m not sure why developing countries are complaining, as it is in their interest to run CA deficits. China is helping to finance their development. Korea does the same thing as China, it accumulates lots of foreign exchange reserves. So that’s the pot calling the kettle black.

    I don’t see a sharp spike in the yuan. China did about 20% of appreciation between 2005-08, and they may well do another 20% over the next 3 to 5 years. That would appropriately reflect the Balassa-Samuelson effect.

    Doug, Newspapers are always saying they are out of ammo, except when they briefly pause to complain about the Fed devaluing the dollar and creating hyperinflation. They are absolutely clueless. I’m convinced most newspapers don’t know that the Fed’s attempt to create more inflation is exactly the same as fiscal stimulus. Not once did I see a new story discussing whether fiscal stimulus would “succeed” in creating more inflation. Yet, that’s how they discuss monetary attempts to create more AD.

  7. Gravatar of Morgan Warstler Morgan Warstler
    19. October 2010 at 07:18

    All of this just makes Mundell look smarter than the rest by a long mile.

    He’s the only one with the nuts to say FUCK THE POLITICIANS.

    Fixed Exchange Rate takes the power out of the hands of the governments – it is the future of monetary policy, and all you heel draggers are either self-interested professors or liberals terrified of a truly global economy.

    The whole learning experience is about the savers in each country banding together globally and telling the the indebted to hand over the hard assets and pronto.

    That is where we head.

    Sooner than later, no government gets to print to help their people, they instead get to alter their policies continuously to emulate the winners – like businesses do: change or die.

    It is FAR MORE NOBLE to accept the peg, and then use the fact that we LOSING to justify making cuts to wages, letting in the best the brightest, cutting corporate taxes to the nub, and gutting public employees.

    We are LOSING… and when you are losing in chess, each pawn-trade, exposes your weakness even more.

    Scott you need to accept the blog title “Papering Over Problems Since 2008”

    We have a dying economy – the wrong people have the hard assets – the wrong people are making decisions, the wrong policies are in place – and if you aren’t SCREAMING about what is wrong – then you are a thief…. hell bent from stealing from the people who saved and DESERVE to own the hard assets.

  8. Gravatar of Adam P Adam P
    19. October 2010 at 07:24

    Another one you might find interesting Scott. Argentina issues NGDP warrants:

    from the prospectus:

    ” subject to the conditions specified below, on each payment date, entitle holders of GDP-linked Securities to receive payments in an amount equal to Available Excess GDP (as defined below) for the corresponding reference year, multiplied by the aggregate notional amount of GDP-linked Securities they hold. “Available Excess GDP” is an amount per unit of currency of notional amount of GDP-linked Securities, determined in accordance with the following formula:

    Available Excess GDP = (0.05 x Excess GDP) x unit of currency coefficient”

    available in USD, EUR, JPY and local currency.

  9. Gravatar of Adam P Adam P
    19. October 2010 at 07:27

    Excess GDP is realized NGDP minus strike.

  10. Gravatar of W. Peden W. Peden
    19. October 2010 at 07:37

    I used to think that Krugman was being deliberately obscurantist regarding the “liquidity trap”, as he vacilitated between a Keynesian liquidity trap and a Krugmanite liquidity trap (and probably a few more definitions that I wasn’t smart enough to notice).

    However, now I seriously begin to wonder if he’s managed to fool himself. His position on the effects of monetary stimulus, as far as I can tell, are totally inconsistent and would not be held by anyone unless they had a pre-existing ideological committment to fiscal stimulus.

    And yet he’s STILL 100 times more coherent than Joseph Stiglitz.

  11. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. October 2010 at 07:38

    Krugman’s last few posts were not nearly as bad as today’s:

    “China is pursuing a weak-yuan policy; to counter the inflationary domestic effects of that policy, it’s pursuing a contractionary domestic monetary policy, reducing overall world demand.”

    That sentence left my head spinning. The problem of capital controls aside, I thought raising rates was merely consistent with their recently stated intention of a gradual revaluation. Is he aware of the contradictions involved, or is he so used to banging the anti-China drum he can’t hear his own head think?

  12. Gravatar of Benjamin Cole Benjamin Cole
    19. October 2010 at 08:40

    OT, but germane: Today the WSJ has an op-ed that almost lays bare the right-wing stance on QE2: Before QE2, we want our tax cuts.

    The op-ed goes on to say that a weak dollar causes manufacturers to invest in overseas factories.

    Just to top it off, the author is David Malpass, deputy asst. Treasury Secretary in the…Reagan Administration, the one in which Treasury Secretary Don Regan publicly lambasted then Fed Chief Volcker for being too tight.

    Sometimes it is just stupifying…..

  13. Gravatar of Morgan Warstler Morgan Warstler
    19. October 2010 at 09:12


    Man, you already KNOW this… AFTER we get the basic structure we like in place THEN we can discuss printing money.

    Why do you act like it is a surprise? Why do you fight it? QE2 isn’t for your side, it is for ours.

    Now do you still like it? We get some nice big cuts to Public Employees, we get the taxes put to rest… then some magic QE2 dust… and our policies solved the crisis!

    Let me ask again… now do you still like it?

  14. Gravatar of Benjamin Cole Benjamin Cole
    19. October 2010 at 09:21

    Well, I wrote this letter to Mr. Malpass (curiously well-named man)

    Dear Mr. Malpass:

    Today’s dunce-cap award goes to you, for that incredibly stupid op-ed you ran in the WSJ.

    A lower exchange rate for the dollar encourages manufacturers to set up shop overseas?

    The CPI overstates inflation? (Try reading up on the Boskin Commission, and a recent peer-reviewed article in the American Economic Review. Due to the constant migration of businesses and consumers to better and cheaper goods and services, the CPI overstates inflation by one percent or so. The core CPIU is at 0.8 percent ow. Ergo, we are in deflation already).

    You served in the Reagan Administration? Was it not your boss, Don Regan, who publicly assailed then Fed Chief Volcker in 1983 to ease up–when the CPI was reading 4 percent?

    Are you aware that real estate is deflating? With serious consequences for investors and banks? That house starts are but one-quarter of peak levels? That office buildings are selling for one-half of highs? There is a depression in real estate.

    I can only assume no one is as ill-informned as you, that your op-ed is some sort of plant. Perhaps some elements feel Obama should be out of office–I concur–and so want the economy to fail before 2012. I cannot concur putting monetary torpedoes into the US economy is patriotic, at any juncture.

    Japan. Read up on Japan. It is a country off the coast of China, if you can’t find it on a map.


    Benjamin Cole

  15. Gravatar of colintj colintj
    19. October 2010 at 10:27

    not exactly on topic, but Yves at naked capitalism has been rounding up anti-QE2 positions from various folks, Stigliz included. might make for some post fodder:

    post ends with:

    “He remarked drily, ‘The record of academic economists as Fed chiefs is poor.’ Sadly, his assessment looks better by the day.”

  16. Gravatar of ang ang
    19. October 2010 at 10:35

    I guess that one thing I’m still confused about is the relationship between currency depreciation, exchange rate, and inflation. It seems that in the monetary view, these are basically aspects of the same thing? Whereas in Krugman’s models they are not?

    I guess what I’m really asking is, suppose China is pursuing an expansionary exchange rate policy and a contractionary domestic monetary policy. Should this have net zero effect on their economy?

    Further suppose the US counteracts the resulting contractionary exchange rate effect with expansionary domestic monetary policy. Does this have the same effect as having both neutral?

    It seems like you’re saying it shouldn’t matter, there is only one variable that matters, NGDP, but Krugman seems to disagree, that it’s more nuanced. Is this an accurate portrayal?

  17. Gravatar of Morgan Warstler Morgan Warstler
    19. October 2010 at 11:09

    In which I loot the banks and save the US Economy without any QE…

  18. Gravatar of TK TK
    19. October 2010 at 13:00

    @Mark A. Sadowski

    China has to raise rates when they sell debt to sterilise the RMB they created when maintaining the fixed exchange rate. Raising rates does not cause currency appreciation in this case because China has capital controls.

    Net effect is aggregate demand in China remains constant, but is shifted from interest-rate-sensitive sectors to export sector.

  19. Gravatar of Mark A. Sadowski Mark A. Sadowski
    19. October 2010 at 16:45

    I believe I mentioned capital controls in my comment.

    So do you agree with Krugman? Do you really think it’s possible for them boost their AD at our expense and decrease their AD at our expense all at the same time?

  20. Gravatar of TK TK
    19. October 2010 at 20:46


    My point is that Krugman’s statement is not contradictory if you believe the capital controls are effective.

    I think it is possible for them to re-orient their demand to support exports rather than investment; and I think that the increased demand for Chinese exports will reduce the aggregate demand faced by US producers, yes.

  21. Gravatar of TGGP TGGP
    19. October 2010 at 22:06

    Karl Smith reconsiders his earlier criticism and interprets Krugman into a more defensible argument here.

  22. Gravatar of Doc Merlin Doc Merlin
    20. October 2010 at 00:42

    “CPI overstates inflation by one percent or so.” No, it USED to overstate price inflation by about 1% back when we used laspyres, now it doesn’t.

  23. Gravatar of Kevin Donoghue Kevin Donoghue
    20. October 2010 at 01:03

    TGGP: “Karl Smith reconsiders his earlier criticism….”

    I don’t think Karl Smith had actually published any criticism of Krugman on this issue. He says: “as a general rule of thumb, when you disagree with a Nobel Laureate on an area closely related to the one in which is received his prize, assume that the misunderstanding is on your part – not his. So, I have been quiet and kept reading.”

    Perhaps you have confused Karl Smith with his co-blogger, Niklas Blanchard? In any case, Smith does seem to get it now. The capital controls are crucial to the story. I’m not sure why people find this so hard to grasp. Perhaps it’s because America hasn’t had effective capital controls for a very long time, if ever. China’s controls are apparently quite effective and that makes a huge difference to the analysis. Discussion which fails to take account of that is pointless.

  24. Gravatar of scott sumner scott sumner
    20. October 2010 at 18:31

    Morgan, Are you sure those are Mundell’s exact words?

    Adam P, Thanks, Shiller has recommended some sort of NGDP asset for the US–I think it was futures.

    W Peden, My thoughts exactly regarding Krugman and Stiglitz. When I have time I’ll have a post on the last from Stiglitz.

    Mark, I know how you feel. If (as Krugman says) we are pursuing an expansionary monetary policy, and if (as Krugman says) it is working, doesn’t that kind of undercut Krugman’s argument that China’s policy are a problem for the US precisely because our monetary policy is powerless?

    Benjamin, Yes, the WSJ has an agenda.

    colintj, I plan a post on Stiglitz.

    anj, There is basically only one true monetary policy, which affects exchange rates and NGDP. But you can also affect the REAL exchange rate through fiscal policy–as when the Chinese government saves a lot. This is the cause of their CA surplus, not easy money.

    Morgan, I didn’t know you have your own blog–I like the Monopoly card–clever touch.

    TK, See my reply to Mark. The contradiction is that he wants to have it both ways on the question of monetary policy effectiveness. Some of his arguments (like China tariffs) only work if m-policy is ineffective, and other arguments (the Fed is weakening the dollar) require exactly the opposite assumption.

    TGGP, I can’t speak for others, but Smith’s defense of Krugman has no bearing on my criticism. I’ve never denied that China’s government artificially creates the CA surplus, or that the currency controls distort the market. My point is that none of that reduces AD in the US, unless the Fed is powerless, and Krugman himself argues it is not powerless (half the time, the other half he says it is.)

    Kevin, Can you name one blogger who found it hard to grasp the point Karl Smith made?

    BTW, no one really knows for sure what would happen if the controls came off. The currency might soar, but a few years ago some very reputable experts argued it might lead to a flood of Chinese money pouring into Western markets. Wouldn’t that be ironic? And even if the free market wouldn’t produce that outcome today, brace yourself because in 20 years a free market in China would be producing exactly that capital outflow.

  25. Gravatar of Kevin Donoghue Kevin Donoghue
    21. October 2010 at 07:48

    “Kevin, Can you name one blogger who found it hard to grasp the point Karl Smith made?”

    Here’s just a couple of examples of bloggers failing to take it into account; I’ve seen many more:

    Ryan Avent: “An effective monetary stimulus in America would probably be the single best way to generate a yuan appreciation against the dollar, as it would alleviate Chinese concerns about the sustainability of global recovery, and it would force China to act to cool the inflationary impact of stronger American growth.”

    Matt Yglesias: “Monetary stimulus plus Chinese currency policy will equal an undesirably large amount of inflation in China. That means that in order to avoid an undesirably large amount of inflation, Chinese leaders will need to engage in a more rapid currency readjustment than they want to.”

    My emphasis in both cases; these statements imply that China really has no option but to allow the currency to rise if it wants to prevent American inflation from spilling over into the Chinese economy. With effective capital controls in place this is false. Karl Smith: “Because China is controlling the flow on money across the border it can have a loose international monetary policy but a tight domestic monetary policy.”

    Incidentally, I’m not asserting that China’s controls are all that effective. I’m in no position to test them. But Krugman clearly believes they are highly effective and anyone who claims to be engaging his argument needs to address that.

  26. Gravatar of ssumner ssumner
    22. October 2010 at 18:29

    Kevin, OK, now I understand your position better. I’ve always taken a moderate position on this issue. I think the exchange controls give China some leeway over it’s real exchange rate, but the leeway is limited and the costs rise as it becomes more distorted.

    I think those quotations you cite can be defended as predictions, even if they don’t address Krugman head on. It is widely believed that the big yuan appreciation of 2005-08 was partly motivated by a desire to address inflation concerns, and I also cite the late 1990s when China had deflationary problems for a time after the East Asia crisis (recall China was one of the few not to devalue.)

    I can’t speak for others, but my objections to Krugman are more pragamtic, or empirical, rather than purely theoretical. Just today I was thinking about how ironic it is that I use the same argument against him in one area, that he uses against me in another. He said that while the Fed could do more, it was dangerous to assume they could do enough. I’d say that while China could absorb a modest currency appreciation with offsetting monetary policies and exchange controls, it’s dangerous to assume the 30% appreciation many are calling for wouldn’t devastate their relatively price sensitive exports. (recall China’s exports tend to be in more competitive industries than the sophisticated capital goods sold by Japan and Germany.)

  27. Gravatar of Doc Merlin Doc Merlin
    26. October 2010 at 15:26


    They already did a 20% appreciation. I would say if anything, its the very bad chinese demographic structures and the far better US capital markets that are combining to cause the trade imbalances.

  28. Gravatar of ssumner ssumner
    27. October 2010 at 17:21

    Doc Merlin, Yes, I think that’s a big part of it.

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